The Financial Crisis and the Politics of Knowing

By Dr. Jeff Mirus ( bio - articles - email ) | Jan 06, 2009

In an interesting article on Democratic Capitalism in the latest issue of First Things, Michael Novak argues that the present financial crisis was caused by failures in the three interdependent systems which make up a free society: the political, the economic, and the moral. It is hard to argue with that assessment but, on the cusp of a new Presidential Administration, the political is inevitably to the fore.

This makes Novak’s description of the political failure even more interesting. Allow me to quote at length:

The core of the crisis lay in the field of mortgages…. Beginning with the Community Reinvestment Act of 1977, the political system helped create this mess. The aim was a noble one: to put as many poor people in homes as possible. And it had its early successes, with more than a million poor people coming to own their own homes for the first time. Indeed, in the 1990s (under the leadership of Franklin Raines and Leland Brendsel) Fannie Mae and Freddie Mac—mortgage lenders secured by government commitments—were given this as their leading purpose.

This was a goal I had shared since at least my 1971 book The Rise of the Unmeltable Ethnics, and I applauded Fannie Mae for this achievement—despite the foresight of my colleagues at the American Enterprise Institute who warned of the eventual costs to the nation. Many in Congress cheered as well, but gradually they did more than cheer. They began to violate age-old banking cautions and practices: forbidding mortgage lenders to demand down payments or to do strict scrutiny of the ability of new borrowers to make regular mortgage payments. They also made mortgage lenders subject to lawsuits—by special-interest groups and pressure groups—if they insisted on what for generations had been thought to be due diligence.

These decisions attracted swarms of speculators to new homes to take advantage of these wholly new and unheard-of incentives. A great many mortgages were granted to well-off people who made use of the incredibly lenient terms to buy or build extra homes for resale. Many economic conservatives warned against this Ponzi scheme. Several attempts by Republican members of the Congress to introduce serious reforms were rebuffed by the friends of Fannie Mae and Freddie Mac in Congress, who insisted that the financing of these two enterprises were [sic] sound and safe: Barney Frank, Maxine Waters, and Christopher Dodd, prominently, with many others joining in.

Independent investigators at last inspected the Fannie Mae accounting books, and massive irregularities were discovered. Top leadership was obliged to resign. But fundamental regulatory changes were blocked. The loose, unregulated practices, defended in the name of noble intentions, were allowed to stand. In a crucial way, the mortgage crisis of 2008 was initiated by specific acts passed by Congress and fiercely defended against detailed warnings about the dreadful consequences to come. All those warnings were dismissed as politically motivated, but they turned out to be accurate.

The first thing to notice about Novak’s account of the political side of the problem is that it doesn’t sound anything like what most Americans would have suspected, based on conventional stereotypes. The conventional understanding goes more like this: Everybody knows that rich financiers and investors offered, sold and traded irresponsible mortgages at the expense of the poor; everybody knows that they were protected by Republican administrations; and everybody knows that the Democrats would never have allowed this to happen. The reality is that prominent liberal Democratic Congressional leaders such as Frank, Waters, and Dodd led the resistance to conservative Republican attempts at reform, because the massive lending had its origins in a social experiment.

My point is neither to make broad generalizations about Republicans and Democrats nor to suggest that political misfeasance was the only cause of the meltdown. My point is simply to observe that in a mass culture dominated by the sound bite, most citizens don’t know enough about real situations to make intelligent political decisions. One wonders seriously about the American dream of basing a virtuous republic on an educated citizenry, or at least about the folly of believing ourselves educated when we are not. For the first mark of an educated person is that he knows, so to speak, what he does not know. And the second is that he distrusts all circular and self-perpetuating opinions based on what “everybody knows”.